Determinants of Resource Demand

Changes in product demand:
[Remember: resource demand is a 'derived demand' from its product]

  • Condition: other things equal
  • Product demand ↑, D for resource involved ↑ (direct relationship)
  • higher product price increase MRP of resources.
  • E.g. The demand for new houses drive up house prices, causing more demand for construction workers and an increase in their wages.

Changes in productivity

  • Condition: other things equal
  • Resource productivity ↑, demand ↑ (direct relationship)
  • 3 ways of altering resource productivity:
  • Quantities of other resources
  • Q of capital + land used w/ labor ↑, MP ↑, productivity of labor ↑
  • Technological advances
  • Quality of capital + land used w/ labor ↑, MP ↑, productivity of labor ↑
  • Quality of variable resource
  • e.g. training, education
  • Quality of labor ↑, MP ↑, productivity of labor ↑

Changes in the prices of other resources
[Depends on whether labor and capital are substitutes/complements in production]

  • Substitute Resources
  • E.g. a receptionist (labor) is substitutable for an answering machine (capital)
  • Substitute Effect
  • Firm buy more of input whose P relatively low + buy less of input whose P has relatively high
  • Output Effect
  • The output effect means that the firm will purchase more of one particular input when the price of the other input falls and less of that particular input whent he price of the other inut rises.
  • – PCAPITAL ↓ → costs ↓ → output ↑ → DALL RESOURCES ↑ → DLABOR ↑
  • Net Effect:
  • If substitute effect>output effect, decrease in price for capital decreases demand for laborI
  • If output effect>substitute effect, decrease in price for capital increases demand for labor
  • Complementary Resources
  • Labor and capital must be used in fixed proportions e.g. one man operates one machine
  • Output effect

In general, the demand for labor will increase when:

  • The demand for the product produced by that labor increases
  • The productivity of labor increases
  • The price of a substitute input decreases, provided the output effect exceeds the substitution effect
  • The price of a substitute input increases, provided the substitution effect exceeds the output effect
  • The price of a complementary input decreases

Elasticity of Resource Demand Optimal Combination of Resources

Elasticity of Resource Demand refers to the relative change of resource demand caused by changes in resource price.
Erd= (percentage change in resource quantity) / (percentage change in resource price)
* Elasticity of Resource Demand 3 main determinants:

  • Ease of Resource Substitutability

High # of substitutes = ELASTIC resource demand
Low # or no substitutes = INELASTIC resource demand
TIME: more time, more elastic

  • Elasticity of Product Demand

DERIVED resource elasticity from product
High product elasticity = high resource elasticity
Low product elasticity = low resource elasticity

  • Ratio of Resource Cost to Total Cost

Large proportion of total cost = High elasticity
Small proportion of total cost = Low elasticity
Optimal Combination of Resources:
Least-Cost Rule:

  • Marginal Product of labor/Price of Labor = Marginal Porduct of capital/Price of capital. More simply: MP(L) / P(L) = MP(C) / P(L).
  • A firm produces using this rule when the last dollar spent on each resource yields the same marginal product.
  • If the equation is not balanced, the firm should produce more (either capital or labor) of the larger number, so that the equation becomes true.

Profit Maximizing Rule:

  • Marginal Revenue Product of Labor/Price of Labor = Marginal Revenue Product of Capital/Price of Captial = 1. Simplified: MRP(L) / P(L) = MRP(C) / P(C) = 1.
  • Minimizing cost does not necessarily maximize profit, but maximizing profit always minimizes costs.